It's been a long time since we saw an innovation that fundamentally changed the way we thought about electric energy. Generation and distribution of electricity hasn't changed a whole lot since the late 1800s when Thomas Edison built a mini-grid in New York, laying the foundation for the grid we know today.
Sure, fuels have changed and there's been an effort to develop biofuels, wind, geothermal, and other renewable energy sources but little has fundamentally changed about the electric energy industry. The truth is, there's only on energy source abundant enough to supply the world with energy and do so cost effectively: solar power.
Over the past decade the solar industry has become economical and is changing the face of electricity distribution. Mini power plants can be installed on homes, in fields, or wherever there's space and power demand. The opportunity created by this industry is tremendous and SunPower (SPWR) is leading the way. Before we get to why I think SunPower is the company that breaks all the rules of energy, let's look at how far the industry has come and why the picture is getting brighter.
The incredible potential of solar power
The amount of solar potential the earth has is almost unfathomable. Enough solar energy hits the Earth every hour to power the world for an entire year. If we could fill the Mojave Desert alone with solar panels we could generate more than double the electricity used in the U.S. each year. The challenge for the solar industry exploiting this potential has always been cost. On that front, the playing field has gone through a seismic shift in recent years.
For some background, electric power costs the average retail consumer in the U.S. about 12.5 cents per watt and grow about 1-3% each year. Until recently, reaching costs that low was a pipe dream for the solar industry, but times have changed.
Today, in the residential market, SunPower, SolarCity (SCTY.DL), Sunrun, Clean Power Finance, and others are building solar systems that feed a home's power needs and sells extra electricity back to the grid at the same retail costs consumers pay, known as net metering. This is not only economical for solar installers, it's so successful that utilities across the country are beginning to fight the rates currently paid to residential solar owners.
Workers installing SunPower panels at California Valley Solar Ranch, a 250 MW project in San Luis Obispo County, California. Image courtesy of SunPower
On the utility side, projects by First Solar (FSLR 2.85%) and SunPower have been contracted at 5.79 cents per kW-hr (about 8.5 cents after NM state incentives) and 10.5 cents per kW-hr, respectively, which is lower than retail costs. SunPower even announced a project in Chile that will be sold directly into the grid on the spot market, just like any other power plant. Grid parity is here and that should mean an explosion in demand for the solar industry.
If solar power costs the same or less than coal, nuclear, or natural gas the decision to go solar is a no brainer. There's little risk in the cost of solar, unlike fuel markets, which can swing dramatically. Better yet, solar power is the only energy source whose fundamental costs are falling. The average PV system in the U.S. has seen costs fall 50% since 2010 and as the industry becomes more efficient costs will continue to fall. No fossil fuel power source can say that.
Just scratching the surface
Wrapping your head around the potential growth ahead of the solar industry is difficult, just because the opportunity is so big. But let's try to at least put it in perspective.
The solar industry will install about 34.7 GW of capacity worldwide this year, according to Bloomberg New Energy Finance. That's up 20% from a year ago, but it's just scratching the surface of the industry's potential.
The U.S. alone has 1,051 GW of power generating capacity and globally there was 5,066 GW of capacity in 2010, the most recent data available. If we assume that solar is generating full capacity 25% of the time (after all, the sun isn't out all day), the industry would have to install about 4,204 GW in the U.S. and 20,264 GW globally to generate enough electricity to power the world. If the solar industry grew 20% annually for the next 20 years it would install 1,330 GW in 2033, a pace that would about cover a 30-year replacement cycle of solar panels.
Maybe growth will be faster, maybe it will be slower; the point is the solar industry has a lot of room for growth. For investors, the opportunity lies with companies who can exploit this opportunity to make a profit. Here's where I think SunPower will stand head and shoulders above the competition.
SunPower is leading the way
I hope I've convinced you that the potential in the solar industry is big. But the challenge has been investing in it profitably. A lot of people have been scared away from module manufacturers like SunPower and First Solar just because they make modules. When the industry saw module prices plummet in 2011 and 2012 these companies were hit hardest and that psychological wound doesn't heal quickly.
But if we take a step back and look at the industry as it is today, I think module manufacturer SunPower provide both the safest and highest potential way to play the industry. The company makes the most efficient, highest quality panels in the industry and it has exposure to every potential growth market there is. This position will set the company up to win long term.
Quality will win in solar
First, let's take a look at efficiency and quality. On the quality side, no one has been able to match SunPower. Third party testing from a variety of companies shows that SunPower panels are more durable and has less degradation than competitors under a variety of testing conditions. This is important because over 30 years the difference between a 0.2% and a 2% annual degradation in power output is significant.
On the efficiency side, no one can come close to SunPower. The company's new X-Series panels are 21.5% efficient and a new manufacturing plant that's under construction promises even higher efficiency. For comparison, First Solar makes panels that are 13.3% efficient and only hopes to be 17% efficient by 2016. Chinese manufacturers are making modules that are 15%-16% efficient and even their best cells can't top SunPower's module efficiency (a cell is a component of a module and therefore has a higher efficiency).
What's important to understand is that having the most efficient and highest quality solar panels in the long term is important. Installers will get more power out of each installation, lowering costs at the end of a system's life cycle. It's also important strategically because the solar industry has proven time and again that lowering costs is easier than increasing efficiency or quality. If I'm going to bet on a module manufacturer, I want one that makes the best, most proven product today, not one that's trying to play catch-up.
A hand in every key market
SunPower's other differentiation is in its downstream business. Unlike First Solar, who focuses on utility scale project, or SolarCity, who is primarily a residential solar installer, SunPower plays in every major market.
Close-up of SunPower's C7 Tracker, which magnifies the sun's light 7X on each solar cell. Image courtesy of SunPower
It's nearly as big in utility scale projects as First Solar and with Total (TTE) as a majority owner it has the backing and connections to build in emerging solar markets like the Middle East, Africa, and South America. Plus, the C7 product that magnifies the sun's power 7X will also leverage SunPower's efficient cells while cutting costs. C7 is in its infance, but if SunPower used all 1.8 GW of cells it makes in 2016 on C7 it could conceivably make 12.6 GW of utility scale solar projects. That's big potential.
On the distributed generation side, SunPower has a $1 billion backlog in commercial installations and a significant share in the U.S. residential market. It's about 1/3 of the size of SolarCity in residential, but that's in part due to a constrained supply of modules, one downside of being sold out.
SunPower has exposure across all different markets, but it also has exposure to different geographies around the world. It's a major player in the U.S. as well as Japan and management has intentionally kept a foothold in Europe, which is where innovations like energy storage will have demand first. Then there are emerging markets like Saudi Arabia, South Africa, and Chile where Total can help push SunPower to take share.
This wide variety of geographical end markets is what makes SunPower a safer play than First Solar, SolarCity, or any Chinese manufacturer. The company can adapt to industry changes and shift to where there's money to be made. It's harder for others to do that.
The bottom line is where SunPower now shines
Making the most efficient, highest quality panels on the market and being geographically diverse is only valuable if you can sell panels and systems for a profit and this is where SunPower has been playing catch-up versus its competitors. Once the company does catch up, this is also where SunPower shows its value to investors and where the real upside is.
If SunPower can lower costs to the point where a higher priced, high efficiency panel produces each kW-hr of power for less it'll be able to sell as many panels as it can make and make more margin than competitors (for more on how higher efficiency overcomes a cost premium click here).
On this front, SunPower has made a lot of progress in the last three years. Look at the gross margin trends of SunPower versus competitor First Solar. First Solar once had a wide lead in cost, but not efficiency. As you can see, falling costs have eaten into that lead and now high efficiency modules are commanding increasing margins.
SPWR Gross Profit Margin (Quarterly) data by YCharts
We can also see these trends in the financial shape of companies across the industry. SunPower has said its panels are sold out through 2014 and its product is in such high demand that it's building another 350 MW of capacity. Between 2012 and 2016, capacity is expected to increase from 1.1 GW to 1.8 GW.
This is just the first leg of expansion for SunPower. CEO Tom Werner has hinted that once the manufacturing technology of the new plant is proven out it can be replicated in new facilities in the future. By 2020, we may be talking about a company selling 3-4 GW of solar panels annually.
Foolish bottom line
SunPower has predicted a non-GAAP profit of $1.30 to $1.50 this year, meaning that shares trade around 22 times the top end of this year's estimates. Given the incredible growth potential in solar, SunPower's lead in quality and efficiency, and the fact that SunPower is sold out through at least the end of next year I think that's a steal for the stock.
Over the next decade, if SunPower can continue to cut costs and expand manufacturing it will gain share in the solar market, giving investors tremendous upside. This is still a nascent industry and taking a leadership position now has positioned SunPower for future success.
That's why I think SunPower is breaking the conventional rules in energy.
